WE NEED A NEW FORM 1098 FOR MORTGAGE INTEREST

Home equity interest is no longer deductible as an itemized deduction on Schedule A.  Period.  There is no “grandfathering” of existing home equity debt.

Only interest paid on “acquisition debt” – a loan secured by your residence the proceeds of which are used to “buy, build or substantially improve” the property – can be deducted.

It does not matter what the lender calls the loan.  Interest on what a bank, credit union or mortgage company calls a “home equity loan” or “home equity line of credit” can be deducted if the proceeds of the borrowing is used to “substantially improve” the residence.

IRS Pub 936 tells us –

“An improvement is substantial if it:

Adds to the value of your home,

Prolongs your home's useful life, or

Adapts your home to new uses.

Repairs that maintain your home in good condition, such as repainting your home, aren't substantial improvements. However, if you paint your home as part of a renovation that substantially improves your qualified home, you can include the painting costs in the cost of the improvements.”

A lender will issue IRS information return Form 1098 “Mortgage Interest Statement” to report interest you pay on a loan secured by a home.  It is required to be issued if the interest paid for the year is at least $600.  This form reports mortgage interest received by the lender, the outstanding principal on the mortgage loan on the first day of the year (i.e. 1/1/2018), the origination date of the mortgage loan, and identifies the property that is used to secure the loan. 

You CANNOT just take the number reported as “mortgage interest received” in Box 1 of the Form 1098 and put this on Schedule A.  This form does not tell you whether the interest received is acquisition debt or home equity debt or a combination of the two.  This is because the lender does not necessarily know with certainty what you did with the money you borrowed.

There has always (or at least since October 13, 1987) been a difference between acquisition debt interest and home equity debt interest and limits on the amount of each type of interest deductible.  It has always been important to keep separate track of acquisition debt and home equity debt.  But it is now more important than ever to do this.

The IRS needs to change the Form 1098 and require mortgage lenders to provide additional information to help the taxpayer, tax professional and the Service itself in determining the correct amount of allowable itemized deduction. 

It would be truly great if the Form 1098 would separately report, with legal certainty, the amount of deductible acquisition interest received and the amount of non-deductible home equity interest received - but this would probably truly be impossible.     However, there is some information that a lender does have that should be included on the Form 1098.

The lender should be able to check a box on the Form 1098 to indicate if the loan is (1) an original acquisition mortgage (a loan used to purchase or build a residence) or (2) a refinance of an existing mortgage.  If the loan is an original acquisition mortgage it is obvious that 100% of the interest reported is eligible for a deduction, within the principal limitations.

When you refinance an existing 100% acquisition debt mortgage only the amount of principal on the loan being refinanced is considered acquisition debt.   The additional closing costs of each refinance that were added to the principal of the refinanced mortgage is home equity debt.  The only way you would avoid home equity debt in such a situation is if you literally refinanced only the principal from each old mortgage and paid all closing costs in cash.

John and Mary purchased a home in 2011.  They have one mortgage, from the original purchase, and no home equity debt.  They want to refinance their original mortgage in 2018 to get a better rate.  The principal balance on the original mortgage is $197,374.  The principal balance of the new mortgage will be $200,000.  They did not take any money “out” and paid a little over $1,000 at the closing.  The difference is the closing costs for title insurance, inspections, fees, etc. etc.  John and Mary now have acquisition debt of $197,374 and home equity debt of $2,626. 

If the loan covered by the Form 1098 is a refinance of an existing mortgage the lender should be required to indicate the principal balance of the loan being refinanced and the amount of closing costs paid by principal of the new loan.  In the above example, the 2018 Form 1098 would report $197,374 in the new box for principal balance refinance and $2,626 in the new box for financed closing costs.   

Do you have any suggestions of other information available to the lender that should be added to a revised Form 1098?   

The IRS has issued a draft 2018 Form 1098, and there appears to be no change to the form. 

Unfortunately, if the 1098-T is any indication, if the information reporting requirements of the Form 1098 for mortgage interest is revised it will be years before complete and accurate forms, properly reporting all the necessary additional information, will actually be issued.  By the time the requirements are all fully phased in the law change will have expired.

FYI, I have prepared a MORTGAGE INTEREST GUIDE with worksheets and instructions for keeping separate track of acquisition and home equity debt.

As usual, any thoughts?

TTFN